Buying a business versus starting a business from scratch has some advantages. Topping the list are an existing customer base and income stream.
Whether you start a business or purchase an existing one, due diligence is a must. Here are six recommendations if you are thinking about buying a business.
1. Beware of claims of unreported cash sales.
This is one of the most common issues faced by prospective buyers. A seller may claim that the financial statements and tax returns don’t accurately reflect the business’s sales. Big red flag!
Consider that the seller has just told you that they’ve not been honest with the IRS, which potentially could result in severe consequences. In a transaction where trustworthiness and honesty are of the utmost importance, hearing that records are inaccurate is a concern.
In addition, should you seek funding to purchase the business, a lender will look only at the tax returns and not include any cash sales in making the loan decision.
2. Get the tax returns and other important documents.
Often, sellers are reluctant to turn over financial information. This apprehension is understandable.
However, a buyer cannot make an informed decision without tax returns and other relevant documents. Further, a lender will require this information.
3. Keep in mind that formal business valuations can be expensive.
How much is the business worth? Most sellers want to reap the reward of years of blood, sweat, and tears. However, the true value of the business may not be reflected in the purchase price.
Overpaying in a buyout can cripple a new owner from the start. Yet, formal business appraisals, or valuations, can cost several thousand dollars. The cost of one can be worth it, relative to the overall value of the business. Or, in some situations, it can be cost-prohibitive.
Regardless of whether you obtain a formal appraisal, you should carefully evaluate what the business is worth to YOU. This requires well-thought-out financial projections for operations under your ownership.
4. Weigh how much the change of ownership will affect customers and employees.
In some businesses, customers won’t notice the change in ownership. At others, the owner is a key reason customers patronize the business.
In addition, any change in employees could influence operations and customer service.
5. Carefully evaluate expected cash flow.
Under a new owner, the business cash flow may change, potentially significantly, due to financing decisions and/or operational changes.
To make a good decision on buying a business, you need to have a clear picture of the cash flow under your ownership.
6. Seek advice from legal and tax professionals.
The type of purchase (stock or asset) makes a difference for both parties. You need to make sure you know how each would affect you from a tax and legal perspective.
Further, the buy/sell agreement is a critical document in the sale. It is best to have an attorney experienced in business transactions work with you on it.
A Final Word
Buying a business is not like buying a loaf of bread. Much research and due diligence are required in this process.
Before you purchase a business, ASBTDC can help you talk through issues and questions, analyze financials and projections, and guide you through the financing process.